There are many common misunderstandings about the estate tax. Many people do not
realize how large the exemption is, and mistakenly assume that the entire estate is taxed.
In fact, it should come as no surprise that most people’s estates do not even approach the
exemption amount.
People often also fail to take into account how inherited property is treated for income
tax purposes. Under current law, if you sell property that you inherit, you pay capital gains
(income) tax only on the amount that the property has grown in value since you inherited it,
not since it was originally purchased. Under some proposals for eliminating the estate tax,
this would be changed so that you would pay capital gains tax on the gain in the property’s
value since it was purchased. Suppose your rich uncle passes away, leaving you $100,000
worth of stock which he bought many years ago for $20,000 and you sell it soon afterward
for $105,000. Presently, you would owe income tax on a $5,000 gain. If that law were
changed as described here, you would pay income tax on an $85,000 gain. For those whose
estates fall below the exemption amount, this sort of repeal of the “death tax” could turn
into a tax increase, rather than a tax cut! (See Exercises 27 and 28 at the end of this section
for an example of this.)
Estate taxes can be a major issue for business owners who want to leave a business “in
the family.” It does sometimes happen that the estate tax on the value of a farm or business
can end up being large enough that the heirs have to sell the farm or business to be able to
raise the cash to pay the estate tax. With the recent increases in the estate tax exemption this
will likely be less of a concern, but even then it is important for business owners to keep
this possibility in mind when planning for the future. A number of attorneys and financial
professionals specialize in helping business owners plan for estate taxes (as well as other
related issues), and there are many strategies that can be used to help financially plan for
any future estate tax issues.
One idea to avoid estate taxes might be to simply give property to your intended
heirs, especially when the donor is in failing health. The gift tax is intended to prevent
people from avoiding estate taxes altogether in this way. Each individual is allowed to
directly give only a limited amount of property to any other individual each year. As of
2006, this limit was $12,000 per recipient per year. A married couple may give $24,000
per recipient (i.e., $12,000 is considered to be from each spouse). Any gift over $12,000
must be reported to the Internal Revenue Service, and is counted against the estate tax
exemption upon death. However, it is not quite that simple; up to a certain point, gifts
that exceed this limit have no actual effect on the estate tax. (Property given to a spouse
or charity is not subject to gift tax; property given to children or grandchildren or others
is, however.)Example 9.4.8 In 2006, Gus gave each of his four children $25,000. He also gave
each of his seven grandchildren $40,000 to pay for their future educations. How much
of these gifts is potentially subject to gift tax?The gifts Gus made to his children and grandchildren exceeded the $12,000 limit and so
the gift tax potentially applies. The amount subject to gift tax was $25,000 $12,000
$13,000 for each of his children, and $40,000 $12,000 $28,000 for each of his grand-
children. This works out to a total of 4($13,000) 7($28,000) $248,000.The effect that this $248,000 will actually have on Gus’s taxable estate when he passes
away depends on many factors and complex formulas. For our purposes, it will suffice to
note that these gifts have the potential to reduce Gus’s estate tax exemption in the future,
and we will leave the specific calculations to the accountants and attorneys who specialize
in the vagaries of the estate tax codes.Taxes: The Whole Story
No one likes to pay taxes. But government can’t be run for free, and the services we expect
from our government have to be paid for somehow. As long as there is a government, there
will be taxes to pay.410 Chapter 9 Taxes